Tax, Benefits, Pensions Keep it simple Part 2: Ten steps ...Proposal 1: Employment and Self-Employment Income Proposal 2: Business Taxation Proposal 3: Reducing the Compliance Burden

of 42, © [email protected] 24/07/2006

Tax, Benefits, PensionsKeep it simple Part 2: Ten steps to simplicity

Mark Wadsworth Chartered Tax Adviser

CONTENTS

Page 2 of 42, © [email protected] 24/07/2006

Part A: Executive summary ........................................................ 3

Part B: Detailed proposals ........................................................ 6

Proposal 1: Employment and Self-Employment IncomeProposal 2: Business TaxationProposal 3: Reducing the Compliance BurdenProposal 4: Investment IncomeProposal 5: Land Value TaxProposal 6: Child Benefit and Nursery FundingProposal 7: A Basic Cash BenefitProposal 8: Citizen’s PensionProposal 9: State Second PensionProposal 10: Private Pension Schemes

Part C: Tax, benefits and the family ...................................................... 27

Part D: Additional gains ....................................................... 30

Economic growthBetter compliance

Part E: Workings ....................................................... 32

Workings 1: National InsuranceWorkings 2: Employment incomeWorkings 3: Business taxationWorkings 4: Land Value TaxationWorkings 5: Benefits – age 65 and underWorkings 6: Citizen’s PensionWorkings 7: Inflation/indexation adjustment

• This report should be read in conjunction Mark Nicholson’s report “Keep itsimple: UK tax system out of control” Bow Group, January 20061

1 http://www.bowgroup.org/harriercollectionitems/UK+Tax+System+out+of+Control.1.pdf

PART A: EXECUTIVE SUMMARY


Most voters, taxpayers, politicians and economists would agree with the followingpropositions:

• Social justice requires a cast-iron safety net for those without full-time paidemployment, but one which does not discourage people from seekingemployment;

• Social justice requires a cast-iron safety net against pensioner poverty, but onewhich does not discourage saving or distort investment decisions;

• Taxes have to be raised to pay for public services and to meet social justiceobjectives, but should be raised in a straightforward and fair manner thanminimises disruption to the economy;

• Taxes should be easy to understand, cheap to collect and difficult to avoid.

The leader of any mainstream political party could have espoused these statements. Yetthe gap between what this implies a tax/welfare system should look like and the systemwe in Britain actually have, is vast, dangerous, and widening. And the true human cost ofthis disconnect makes the political ineptitude that has brought it about unforgiveable.

The British economy has 1.6 m fewer jobs than it should; perverse incentives in thehousing market force young families to make do with cramped accommodation while 1 mpoorer pensioners have three or more spare rooms; numerous tax loopholes enable therich to avoid paying their fair share; the triple burdens of creating, administering, andcomplying with a tax system of such complexity actively discourage millions fromengaging in productive economic activity; perhaps most scandalous of all, many of ournation’s poorest - those who need money and the necessities it buys most - do not collecttheir fair share of social benefits, because the complexity of doing so is so great.

Too often the debate about tax in Britain has focused solely on the end - the size of thestate. There are many respectable arguments for and against big government, anddoubtless the argument will run and run. But there are no respectable arguments for theburdens imposed by a complex tax system. Thinking politicians of all parties need to joinforces and forge a consensus in favour of fundamental reform of the way the governmentraises money, to bring it into line with the principles in which they claim to believe.

It may as come as a surprise to learn that the entire UK2 tax, benefits and pensionssystems could be replaced on a fiscally neutral basis by ten simple proposals. This is not amenu3; it is a consistent, coherent and inter-locking system that will have more netwinners (particularly among low- and average earners) than net losers, although in anyparticular case, the net gains or losses will not be particularly large.

2 This excludes VAT, which is largely dictated by EU rules.3 Thanks to Graeme Leach for this expression



Summary: Ten steps to Simplicity

1. Employment and Self-Employment Income: The personal allowance will beincreased to £11,000. Employee’s National Insurance and Working Tax Credits willbe scrapped and amalgamated into a single income tax rate of 38% on all earnedincome above the personal allowance.

2. Business Taxation: Employer’s National Insurance will be scrapped and corporationtax will be increased to 38% on all trading, professional or rental income. Gimmickytax breaks such as R&D tax credits or the Corporate Venturing Scheme will bescrapped. Business rates will be reduced to 30% of the rateable value, withoutexemptions for unoccupied business premises.

3. Reducing the Compliance Burden: The UK’s tax year-end will be set to 31December. Businesses will pay tax on their accounts profits, subject to pragmaticadd-backs; unnecessary complications such as the schedular system and capitalallowances will be scrapped.

4. Investment Income: There will be no higher rate tax on dividends from, or CapitalGains Tax or Stamp Duty on disposals of shares in UK companies. Non-repayableincome tax at 20% will be deducted from all bank and bond interest, with no furthertax being due. Gimmicky tax breaks such as ISAs, PEPs and TESSAs, EIS, VCT andFilm Reliefs will be scrapped.

5. Land Value Tax: Council Tax, Stamp Duty Land Tax, Capital Gains Tax ondisposals of land and buildings, Inheritance Tax and the TV licence fee will bescrapped and replaced with a “Land Value Tax” of 1% per annum on the value of allresidential properties. The first £70,000 in value per household will be exempt.

6. Child Benefit and Nursery Funding: Child Benefit will be increased to £36 perweek for children under 5. £60 per week will be paid towards nursery costs forchildren aged 2-4.

7. A Basic Cash Benefit: Adults not in paid work (or earning less than £11,000) will beentitled to a non-contributory, non-means tested, non-taxable Basic Cash Benefit(“BCB”) of £80 per week, but will not also be entitled to a personal allowance for taxor PAYE purposes.

8. Citizen’s Pension: From age 60, the BCB will increase by £3.75 per week for eachyear of age, up to age 71, at which point it will reach the maximum of £125. At age 66the payments will be re-branded as “Citizen’s Pension”.

9. State Second Pension: The State Second Pension entitlement will be frozen andphased out over time.

10. Private Pension Schemes: Tax relief for private pension contributions will be 38%,but restricted to the first £4,400 gross contributions per annum (£2,728, net of tax).



Most of the proposals are cost/revenue neutral (benefits, pensions, investment income,land value taxation). Changes that are not inherently cost/revenue neutral are listedbelow; tax reductions/extra spending in parentheses and additional tax revenues/costsavings as positive figures.

Employment income £(18.2)bn Proposal 1

Self-employment income £(1.5)bn Proposal 1

Business tax £(4.1)bn Proposal 2

Costs of tax collection £1.5 bn Proposal 3

Savings in benefit administration £2.0 bn Proposal 7

Tax Credits written off £2.0 bn Proposal 7

Citizen’s Pension £(0.2)bn Proposal 8

SERPS/S2P £2.7 bn Proposal 9

Inflation/indexation adjustment £15.8 bn Workings 7

£0.0 bn

Summary of Benefits

The immediate benefits of the proposals discussed in this paper fall broadly under twoheadings: fairness, and efficiency.

FairnessOverall, those on low or middle incomes will gain (see Part C: Tax, benefits and thefamily) and the wealthy will lose a number of tax breaks and loopholes. Pensionerpoverty will become a thing of the past. Punishment (in the form of Inheritance Tax) forpassing wealth on which tax has already been paid to one’s children will be scrapped.The Basic Cash Benefit will put the principle of equality at the heart of the benefitssystem, in place of a system skewed towards the interests of those who study rulesclosely, know their entitlements and excel at playing the system.

EfficiencyPerhaps the biggest efficiency gains will stem from the millions of hours currentlydevoted to form-filling, which can now be put to productive use. Part D explains howthe new system will boost employment, and hence the economy as a whole, and givesideas for reducing the shadow economy and thus broadening the tax base. As a result, it islikely that overall tax receipts will increase, enabling modest tax cuts and/or reductions ingovernment borrowing.

PART B: DETAILED PROPOSALS: INCOME/CORPORATION TAX


Proposal 1. Employment and self-employment income

• The personal allowance will be set at £11,000;• Working Tax Credits will be scrapped• Employee’s NI will be scrapped; and• A standard income tax rate of 38% will apply to all earned income over the

personal allowance.

Rationale

The personal allowance of around £5,000 is ridiculously low; so much so that lower-paidworkers are simultaneously benefit claimants and taxpayers. This creates a hugeadministrative burden, as well as uncertainty, and causes a total marginal tax/benefitwithdrawal rate of between 70% and 100%4. A level of £11,000 will exempt somebodyworking full time for the National Minimum Wage from tax entirely and corresponds tothe level at which the Working Tax Credit for a single earner is abated to nil. WorkingTax Credits may have channelled extra money to the poorest families but in all otherrespects they have been a disaster (see Proposal 7 and Part C: Tax, benefits and thefamily).

National Insurance is a super-tax on labour and means that employment income is taxedmore heavily than any other source of income.

A legitimate aim of taxation is to discourage socially or environmentally harmfulbehaviour – drinking, smoking, gambling – or at least to raise revenue with minimaldamage to the mainstream economy. Another legitimate aim is to ration scarce resources,especially if they are imported. Fuel duties can be justified under any of these heads.

Labour is neither harmful – it is the ultimate source of most wealth and a very efficientway of distributing income – nor is it a scarce resource, nor does it need to be imported;there are 8m people under 65 in the UK who are not in work. NI is also an administrativenightmare for employers to have to run two parallel systems where there is in fact a 99%overlap between what is being charged to tax.

People have been led to believe that NI payments “go towards their pension”, which isnot actually true, see Proposal 8.

Under the current system, the true marginal rate of income tax, NI and Tax Creditwithdrawal for most employees is between 33% and 48%. Taking the more-than-doubledpersonal allowance into account, a fair and fiscally neutral rate is around 38%. The tableon the next page shows the increase in net income for employees at various salary levelsunder the new system.

4 see the DWP’s Model Tables at http://www.dwp.gov.uk/asd/asd1/TBMT_2005.pdf



Impact

Very low paid and part time workers earning less than the personal allowance will beallowed to claim the BCB (see Proposal 6) but will forego the personal allowance. Insteadof paying income tax and losing benefits, they will just pay income tax, which will doubletheir net hourly income.

Under the new system, workers on low to average wages will have significantly highernet incomes as follows:

EarningsEmployee, single, not

contracted-outSelf-employed, single

Tax saved (2004-05 rates)£11,000 £1,823 £1,635

£15,000 £1,623 £1,315

£20,000 £1,373 £915

£25,000 £1,123 £515

£30,000 £873 £115

£35,000 £295 £(514)

£40,000 £239 £(571)

£45,000 £389 £(421)

£50,000 £539 £(271)

Average £920 £302

The savings made by the self-employed will be lower as they pay 3% lower NIcontributions than employees. Taxing self-employment income in exactly the same wayas employment income will save a lot of pointless arguments with HMRC over ataxpayer’s employment status. The self-employed will still benefit from the easing of thecompliance burden and, if they are also employers, from the fact that Employer’s NI willbe scrapped.

Receipts (2004-05)Current PAYE receipts5 £108.7 bnEmployees’ NI (see Workings 1) £35.1 bnTax credits (“negative income tax” element) 6 £(4.4)bnTotal £139.4 bn

Expected receipts (see Workings 2) £121.2 bn

Reduction in tax burden on the self-employed7 £1.5 bn

5 HMRC Tables 2.8 and 2.96 Of total £13.8 bn entitlement shown in HMRC’s Annual Report for 2004-05, £4.4 bn is included inHMRC’s Table 2.9 as “negative income tax” and the rest is treated as benefits.7 5m self employed @ £300 each.



Proposal 2. Business taxation

• Employer’s NI will be scrapped (see Workings 1)• Corporation tax will be increased to the same rate as income tax of 38%.• Business rates (42.6% of “rateable value”8, half rates for unoccupied premises)

will be harmonised at 30%, whether occupied or not and SDLT will be scrapped(see Proposal 5).

• Gimmicky tax breaks such as R&D Tax Credits and the Corporate VenturingScheme will be scrapped.

Rationale

Scrapping Employer’s NI will cut the cost of labour and hence boost employment – seeWorkings 1

Setting corporation tax at the same as income tax seems fair and certainly makes thingsmuch simpler. Having wildly disparate tax rates positively invites avoidance (bychannelling earned income through a limited company), and to save the need for higherrate income tax on dividend income (bearing in mind there will be no basic and higherrates, just one uniform rate, see Proposal 3) or the dreaded “Section 419” tax.

Business rates are just over 40% of the “rateable value” of all business premises, oraround 4% of the capital value of the premises. To confuse the issue, there are discountsfor small businesses and a 50% reduction if the premises are unoccupied, with yet moreforms and administration. If it is agreed that leaving perfectly good business premisesvacant is a bad thing, why reward it via this reduction? In any event, the rate seemsunduly high, so it makes sense to harmonise business rates at 30% for all businesspremises, whether occupied or vacant.

Pharmaceutical companies and Formula 1 teams, who between claim the bulk of theResearch & Development tax credits, are just continuing to do what they do best. There ismore madness involved here; for some reason only companies can claim R&D tax credits,not sole traders or partnerships. R&D spending actually fell in 2004-05 to £13.5 bn9; thevalue of the R&D tax credits was around £1.4 bn, so it seems presumptive in the extremeto claim that R&D tax credits boost R&D spending.

Impact

The knee-jerk reaction is that UK plc does not want to see corporation tax rates increasedfrom 30% to 38%. People do not appear to realise that UK plc pays as much inEmployer’s NI as it does in corporation tax. The overall effect of the measures suggestedabove will be to reduce the tax burden slightly. Thus post-tax profits will increaseslightly, but more importantly pre-tax profits will increase by a quarter.

8 It is in fact a super-tax on actual or deemed rents paid/earned by businesses9 FT 25/3/06



The measures will not necessarily increase the total tax burden on companies currentlypaying at the small companies’ rate of 19%. Small employers who pay out more than75% of their gross profits (before salaries) as salaries, and in particular companies caughtby IR35 will pay less in tax than presently. The break-even point for companies withprofits between £300,000 and £1.5m (taxed at a marginal rate of 32.75%) will be lowerand the break-even point for companies currently paying corporation tax at 30% is wheresalaries are 60% or more of gross profits.

Most investment (market research, product development, plant and machinery, stafftraining etc) is paid for out of pre-tax profits. If pre-tax profits increase by a quarter, thenit is not inconceivable that investment will increase by a quarter. Further, ultimately, thecost of all inputs is 99% labour. Employer’s NI adds around 8% to the cost of labour, soscrapping Employer’s NI will reduce the cost of labour by 8%. Thus if UK plc has aquarter more money to spend on something that is 8% cheaper, the two measures, takentogether will boost investment by a third, with a corresponding boost to employment (seePart D: Additional gains)

Assuming that the bulk of R&D costs are salaries, if R&D tax credits and NI are scrappedsimultaneously, the pre-tax cost of R&D will probably fall slightly10, so there is no reasonto assume that R&D spending will continue to fall.

Although the headline corporation tax rate will increase, it will still be broadlycomparable with other large European economies. Under the new system, they will havethe worst of both worlds – high Employer’s NI rates as well as corporation tax rates of33.3% (France), 37.25% (Italy) or around 38% (Germany - 25% corporation tax plus 13%Gewerbesteuer)11. Thus the UK is uniquely placed to steal a march on the other large EUeconomies; if not in terms of the headline corporation tax rate, then at least in terms ofscrapping Employer’s NI.

Current receipts 2004-05Corporation tax12 £33.6 bnEmployer’s NI13 £30.7 bnBusiness rates14 £18.7 bnR&D Tax Credit refunds (to small companies) £(0.5)bnSDLT (see Proposal 5) £1.6 bn

£84.1 bnExpected receipts (see Workings 3)Corporation tax £65.8 bnBusiness rates £14.2 bn

£80.0 bn

10 Large company pays £100 salary plus £12.80 Employer’s NI and claims extra tax relief at 30% on 25% x£112.80; the R&D rebate is £8.46, £4.34 less than the NI paid. A small company claims extra relief at 19%on 50% x £112.80, so gets R&D rebate of £10.72, again less than the Employer’s NI.11 FT 6/4/0612 HMRC Table 11.2, 2004-0513 See Workings 114 Public Sector Finances Databank, Table C4



Proposal 3. Reducing the compliance burden

Rationale

As mentioned in the executive summary, taxes should be easy to understand, cheap tocollect and difficult to avoid. There are various aspects of our system that are anunnecessary burden on UK plc and particularly irritate overseas businesses and hencemake the UK less attractive for inward investment. The tax systems of other countriesprovide plenty of ideas on what can be done to simplify taxes on a fiscally neutral basiswhile easing the compliance burden.

Recommendations

The UK’s tax year-end of 5 April should be re-set to 31 December, in line with all othercivilised countries in the Northern hemisphere. Ireland, whose tax system is very similarto ours, chopped off the 2001-02 tax year on 31 December 2001, and since then has usedthe calendar year, without any apparent harm being done to the economy. Nobody iscrying out for the 5 April year-end to be reinstated.

The UK is unusual in that completely different bodies administer different taxes.Although nominally all under “H M Customs & Revenue”, the truth of the matter is thatthere is little communication between departments. Each business will submit itsaccounts, income/corporation tax returns, PAYE returns and VAT returns to one office.VAT quarters will be harmonised with the year-end. If a business uses a year-end otherthan 31 December, it will be required to prepare two PAYE returns a year (similar to thefifth quarter for CT61 returns). With its accounts it will submit a reconciliation showinghow the salaries per the accounts tie in to the PAYE returns and the turnover to the VATreturns. Thus one civil servant will be able to spot the worst discrepancies straight awayand will also keep an eye on revalued properties and the value used for Business Rates.New businesses will only have to register once with their local office.

The costs of running a payroll will be minimised. The P35 will be a spreadsheet showingrelevant details, which HMRC can re-run and compare with the total PAYE paid.Employers will no longer have to deal with SMP, SSP or Student Loan Repayments. Ifemployers want, they can treat employees as part-time, in other words, withhold a flat38% from all salaries and arrange for the DWP to pay them the BCB – mathematically,employees will be neither better nor worse off. The nonsensical system of having toreport expenditure with a private benefit separately will be scrapped. Employers will addthese back to their taxable profits, exactly the same as for private expenditure that isadded back in sole trader or partnership accounts. Only non-taxable entities will have toreport these separately.



In most countries, a company (or indeed a group) is deemed to be carrying on a singlebusiness; there is no need for the Schedular system. The capital allowances system isanother huge area of friction; in exchange for accelerated tax relief on certain assets, thedepreciation on other assets is disallowed entirely.

Other countries manage perfectly well by allowing the accounts depreciation for taxpurposes, so there is no reason why the accounts profit should not be assumed to be thetaxable profits, subject to pragmatic adjustments for private expenditure; depreciation,revaluation and realisation gains and losses on capital assets (mainly freeholds andshares); interest income that was received net of tax (see Proposal 4) and income fromabroad which has already suffered tax.

The filing deadline for Companies House, HMRC and the due date for payment ofcorporation tax will be harmonised at (say) ten months after the year-end. Corporation taxinstalment payments will be based on the lower of last year’s and this year’s profits, thesame as for individuals under Self Assessment. Groups will pay on a group basis.

The Construction Industry Scheme (“CIS”) is a bizarre scheme that parallels the VATsystem and overlaps rather clumsily with PAYE and income tax/corporation tax. Underthe scheme sub-contractors who are neither employees nor proper businesses have 18%tax deducted from payments made as a rough approximation of their overall tax liability.The scheme will be scrapped. Legitimate sub-contractors will continue to paid gross,everybody else will go on the payroll. If a worker is neither a registered business nor hasa PAYE code, he will be taxed at 38% on all payments.

Impact

The compliance burden on UK business will be significantly eased. Tax advisors andsolicitors will have to find other ways of occupying their time. Admittedly, howeversimple the rules are, there will still be complicated areas and marginal situations wheretax planning is required, but the lines between evasion and avoidance will be muchclearer. As it takes three private sector workers to sort out the red tape and nonsensegenerated by one civil servant, the saving to UK plc will be many times the saving to thetaxpayer of £1.5 bn.

In addition, a simpler tax system with cheaper labour (via the scrapping of NI) will makethe UK a far more attractive location for inward investment.

HMRC has 100,000 employees and running costs of £3 bn15. The new system will be sosimple that half of these employees will no longer be needed. One quarter will be neededfor routine work, a quarter to sniff out and tackle tax evasion, saving £1.5 bn.

15 HMRC Annual Report for 2004-05



Proposal 4. Investment income

• “Plain Vanilla” interest income from bank accounts or corporate bonds will betaxed at source at 20% with no further income tax being due16.

• Dividends from UK shares will be exempt from further tax, as company profitswill be taxed at the same rate as personal income (see Proposal 2).

• Sales of shares will be exempt from Capital Gains Tax or Stamp Duty. There willbe no relief for capital losses.

• Gimmicky tax breaks such as TESSAs, PEPs, ISAs and EIS or VCT relief will bescrapped (unnecessary)

Rationale

There are various taxes levied on savings and investment income and the underlyingcapital, for example: Stamp Duty and Capital Gains Tax on sales of shares; higher rate taxon dividends; income tax on interest income and benefits withdrawal for people who havesome savings (effectively a tax on capital). On the other hand, there are various tax reliefsdesigned to encourage savings and investment (above and beyond tax relief for pensioncontributions), for example: EIS and VCT reliefs; reinvestment relief for capital gains;PEP, TESSA, ISA accounts; Film reliefs etc.

The revenues raised by taxing savings and investments are broadly equal and opposite tothe “cost” of the tax breaks. Wealthier taxpayers pay the taxes and benefit from the taxbreaks. Thus, it makes more sense to reduce each side of the equation as far as possible.

Take for example interest income:- Tax-exempt savings accounts boost the net interest income of higher rate

taxpayers by two-thirds (5% interest net of 40% tax is 3%, 5% tax-free is 5%) butof basic rate taxpayers by only one-quarter (5% interest net of 20% tax is 4%, 5%tax-free is 5%).

- Means testing of benefits punish poor people very savagely for having saved inthe first place.

- With inflation of 2.5% and nominal interest rates at 5%, it seems fair to say thatonly half the nominal interest that you earn is profit; the other half iscompensation for fall in purchasing power.

- Most households pay more non-tax deductible interest (on their mortgages) thanthey ever receive as deposit interest; broadly speaking those who have paid off thelargest mortgages will probably earn the most deposit interest later in life.

- Out of total bank accounts and corporate/Treasury bonds in issue of (say) £1,500bn, a meagre £2.6 bn is collected in tax on the interest. HMRC’s Table 3.8 for2003-04 shows total taxable interest income of £9.8 bn. If £1,500 bn bank depositsand Treasury and corporate bonds pay interest at 4% and 20% non-repayable taxwere deducted17, regardless of residence or status of the recipient, the take wouldbe £12 bn, less a one-fifth margin of error = £9.6 bn.

16 Does anybody still remember the “composite rate” system? That worked perfectly well in practice fordecades, despite having no statutory basis.17 As recommended by the EU Savings Tax Directive.



UK plc will pay corporation tax at the same rate as income tax, so there will be no need tocharge higher rate tax on dividends. Ultimately, dividends from companies in treatycountries with a sensible corporation tax/withholding rate will be exempt as well. Out ofaround £60 bn paid out in dividends in 2004-05, only £4.3 bn was collected as higher ratetax (25% of cash dividends received), because three-quarters of dividends are paid to non-residents, other UK companies, unit trusts, investment trusts, pension funds, basic ratetaxpayers or people who simply do not declare dividend income.

Capital Gain Tax receipts are less than a tenth of what one would expect (£1.1 bn againstaverage growth in value of FTSE All Share index of £50 bn per annum), because mostshares are owned by pension funds, unit trusts and investment trusts; because they areheld in ISAs and PEPs; because they are owned by non-residents; because the gain fallsunder the annual exempt amount; because the gain is covered by losses brought forward,March 1982 rebasing or can be sheltered by reinvestment relief or, just as likely, becausesome people simply do not declare capital gains.

EIS and VCT reliefs are probably pointless, if not counter productive. Good investmentopportunities will attract capital anyway. A poor investment opportunity dressed up witha tax break will attract capital – and then lose it. Under the new system companies will beable to surrender losses to individual as well as corporate shareholders, so investors canclaim up to 38% tax relief on the amount they subscribe if the company fails. Do notforget that all shares will be exempt from capital gains tax, not just EIS or VCT sharesand that there will be no further tax on dividends (see Proposal 3). EIS and VCT reliefswill therefore be completely superfluous.



Impact

If an evader can choose between 20% tax or trying to earning interest tax-free with anoffshore accounts and risk paying the full 38% when he is caught out, he is more likely tochoose to suffer the 20%, which may involve the repatriation of funds to the UK.

Taxes on investment income and the corresponding tax breaks are an irritant; they raiselittle net tax overall and are not even redistributive; they impede the efficient allocation ofcapital that would occur in a truly free market. The taxation of investment income can bereformed and simplified on a completely fiscally neutral basis that encourages liquidityand removes distortions, ensuring a better allocation of capital overall.

The new system will also greatly simplify the preparation of tax returns; most investmentincome will no longer have to be reported on the tax return.

Current receipts18

Higher rate tax on dividends £4.3 bnBank interest - TDSI £2.6 bnStamp Duty on share sales £2.5 bn19

Rental income (@ average rate 31%) £1.8 bnCapital Gains Tax20 £1.2 bnOther investment income £0.6 bnEIS and VCT reliefs £(0.4)bn21

Film reliefs £(0.5)bnTotal £12.1 bn

Expected receiptsNon-repayable tax deducted from interest £9.6 bnRental income (@ 38%) £2.2 bnOther investment income (overseas div’s exempt) £0.3 bnTotal £12.1 bn

18 HMRC Table 3.7 for 2002-03. They admit that the figures are very approximate.19 See Proposal 520 HM Treasury – Public Sector Finances Databank, Table C4. Total CGT £2.3 bn, 50% allocated to sharesales and 50% to property sales – see Proposal 5.21 HMRC Table 1.5

PART B: DETAILED PROPOSALS: LAND VALUE TAX


Proposal 5. Land value tax

• Council Tax, Stamp Duty Land Tax, Inheritance Tax, the TV licence fee andCapital Gains Tax on the sale of land will be scrapped and replaced with…

• … a Land Value Tax (“LVT”) on residential properties at 1% of current marketvalue, subject to a nil rate band of £70,000 per household/dwelling

Rationale

The main aim of this report is to show how the current tax system can be reformed on afiscally neutral basis such that most people are neither significantly better nor worse off.This is a golden opportunity to replace five hideously complicated and/or arbitrary taxes(and one arbitrary benefit) with a simple, fair and economically efficient tax.

There are excellent economic arguments in favour of an annual tax as a fixed percentageof the value of your home:22

- Housing is a normal good, in other words, the value of your home is a fairly fixedmultiple of your lifetime average income. Thus such a tax is “fair” in the sensethat it is an extension of income tax, the least unfair of all taxes;

- It encourages efficient use of housing. Once the children have left home, there areonly sentimental reasons why older couples or widowed pensioners should nottrade down into smaller properties, freeing up larger homes for young families;

- The current house price bubble has been due in part to increases in demand. Suchincreases can be dampened by introducing a land value tax, especially for under-utilised second or holiday homes;

- LVT is not a new idea and several countries already have it - seewww.landvaluetax.org.uk or www.labourland.org;

- LVT is difficult to avoid. You cannot stick a house into a briefcase and take it tothe Cayman islands.

On a closer inspection, the UK already has several competing and overlapping taxes thatroughly approximate to LVT as follows:

The “Guide to Council Tax 2006/07” shows that Council Tax in the London Borough ofWaltham Forest is basically a poll tax element of £500 plus a land value tax element of0.35% the home’s value, capped at around £750,000. See alsowww.counciltaxreform.org. House prices in LBWF are probably 50% higher than thenational average and Council Tax is 10% higher, so the nationwide picture is probablymore like £500 poll tax element plus 0.5% of property value.

Council Tax Benefit (“CTB”) is designed to compensate for the poll tax element thatensures a minimum level of tax. The total CTB paid out is £3.6 bn, claimed by around 5mhouseholds or £14 per week per claimant household23. There is a high correlation betweenCouncil Tax bands and CTB claimants – around 75% of people in Band A are entitled,50% in Band B and 25% in Band C24. As usual, there are problems with poor take-up,

22 See for example the report by the National Institute of Economic and Social Research, FT 27/1/0623 DWP Quarterly Statistical Summary, January 200624 Figures for 2001, DWP.



fraud and error and the fact that it is means-tested, contributing yet another 6% to 13% tothe marginal tax/benefits withdrawal rate of low and part time earners.

The nil rate band for Inheritance tax (“IHT”) is £275,000; above that it is charged at 40%on the value of the deceased’s estate. Only the richest 6% of estates are liable to IHT25.The richest 5% of households own 43% of all “marketable wealth”26. The total value ofUK wealth (homes, investment properties, shares, bank accounts etc.) is around the£6,000 bn mark. Thus the richest 6% of households are on average worth £1.8m each.Assuming everybody lives to an average age of 70, each year 30,000 estates would bechargeable to IHT. Assuming no IHT planning whatsoever, this would mean IHT of£610,000 per estate x 30,000 estates, a yield of £18.3 bn. The total take was actually only£2.9 bn in 2004-05, or £100,000 IHT per estate, suggesting that the average total estate ofthe richest 6% was only £525,00027. The average value of the main residence of therichest 6% is at least that much. The rest must have been salted away via tax planning. So,IHT is basically a one-off tax on the value of your home on death. IHT taxes the parts thatCouncil Tax can’t reach.

The TV licence fee raises £2.8 bn gross (less maybe 10% collection costs), roughly asmuch as IHT or CGT and adds 10% to the average Council Tax Bill. As a particularlyunfair poll tax that falls heaviest on single person households and home owners (tenantsare more likely to be non-payers), the TV licence fee will be scrapped28.

LVT is designed to ensure efficient use of available housing, in other words toencourage/enable people to move into the “right size” home, be that larger or smaller.Therefore, it would be hypocritical to charge SDLT at savage rates up to 4%, a tax thatmay be legally due by the purchaser but is economically borne by the vendor. Ifpensioners decide to trade down from a £500,000 house to a £200,000 flat in order to cuttheir LVT bill by two-thirds, they should not be fined £20,000 for doing so.

Impact

Owners of the cheapest one-fifth of properties will pay no LVT whatsover and owners ofcheaper properties will pay less LVT than they did Council Tax/TV licence fee. Those inthe the middle will be indifferent. Owners of more expensive properties will of coursepay much more in LVT, but this is not unfair. Higher earners will have a marginal incometax rate that is 3% lower, and will not have to pay tax on capital gains or dividends; non-working spouses will be entitled to the BCB of £4,160 per annum; LVT will just be IHT,CGT and SDLT in easily affordable instalments.

Pensioners will be allowed to roll up unpaid LVT with interest to be repaid on death/sale.

Scrapping IHT will be warmly welcomed by the richest 6% of households who actuallyhave to pay it, as well as with the next tier of households who have to worry about it andengage in complicated and expensive avoidance schemes. Conversely, it will be

25 Gordon Brown, Budget speech 22 March 2006.26 http://www.statistics.gov.uk/cci/nugget.asp?id=227 £525,000 less £275,000 x 40% = £100,000.28 Apparently, it is now officially a tax and has thus been removed from the RPI shopping basket.



unpopular with those on the Left who believe that the tax system should be designed topunish the wealthy, even if the tax raised from the exercise is minimal.

Scrapping CGT on long-term property investments will ensure more liquidity in thehousing market; especially for owners of holiday and second homes who may have to payhigher LVT bills.

Scrapping SDLT will be very popular with home buyers/sellers and conveyancingsolicitors who have to fill in fairly nightmarish 80-page SDLT forms for anything but thesimplest transaction.

Recent research from the IPPR29 that found that “There are almost a million ‘asset-richincome-poor’ pensioners - who own more than £100,000 of housing wealth but are onmeans-tested benefits” and “Half of retired people living on less than £128 a week havethree or more spare rooms.” Under the current system, there is little advantage to suchpensioners in trading down to a smaller property, as the income generated from the equityreleased would be wiped out by the loss of means tested benefits (primarily PensionsCredit and Council Tax Benefit). Under the new system, no older pensioner need live inpoverty anyway, but they will not be discouraged from trading down; there will be noSDLT hit; no loss of means tested benefits and interest income will be taxed at half rates.

Even if only 10% of all pensioner households were to trade down over the next five years,this would mean an extra 150,000 houses coming on to the market each year; which isroughly the number of new houses built every year. The overall effect of this will be toboost pensioner incomes and make it much easier for first time buyers and families livingin flats to find a family home.

Current receipts30

Council Tax £20.2 bnless Council Tax Benefit31 £(3.6)bnStamp Duty Land Tax32 £4.9 bnInheritance Tax £2.9 bnTV licence fee (net of collection costs) £2.5 bnCapital gains tax33 £1.1 bnTotal £28.0 bn

Expected receiptsLand Value Tax (see Workings 4) £28.0 bn

29 http://www.ippr.org.uk/pressreleases/?id=213530 HM Treasury – Public Sector Finances Databank, Table C4, unless stated31 Department of Work & Pensions, Table 3, 2004-05 estimated outturn32 Total Stamp Duty and SDLT is £9.0 bn, but £2.5 bn relates to pure Stamp Duty. I have allocated onequarter to businesses (see Proposal 2) and three quarters to households.33 50% of CGT receipts have been allocated to share disposals and 50% to land and buildings.

PART B: DETAILED PROPOSALS: CHILD BENEFIT


Proposal 6. Child Benefit and nursery funding

• Child Benefit will be a flat £18 per week for every child aged 5 – 16.• Child Benefit will be at higher rates of £36 for children under 5 and £24 per week

for children aged 17 - 1834.• Child Tax Credits, IS/JSA related child allowances and all other child-related

benefits will be scrapped.• £60 per week will be paid towards nursery costs for children aged 2 – 4 where

both parents or the lone parent is working; various parallel systems for subsidisingnursery care will be scrapped.

• Ultimately, the £60 will be extended to all children aged 2 – 4 at nursery, whethertheir parents are working or not; the extra cost does not justify the hassle ofactually policing this, and as soon as finances allow, the £60 will be increased tocover the full costs of a nursery place.

Rationale

The whole system seems to be geared towards the “Mummy stays at home with John andJanet while Daddy goes to work” model that may have been valid decades ago, but doesnot reflect the modern reality that the employment rate is the same for men and women.

Nowadays, most couples are both working before they have children and although ChildBenefit of £18 per week is probably a fair contribution to the incremental cost of having achild in the household, extra food, clothes, toys etc, the real – and for many couplesinsurmountable – financial barrier to having children is not that bit of extra food, butrather the loss of the mother’s wages for the few years that she takes off work. StatutoryMaternity Pay (£106 for a laughable 6 months) will of course be rolled into the BCB. TheBCB is only £80 per week, so Child Benefit for children under 5 will be at a higher rateof £36 per week.

It is almost universally accepted and expected that children over the age of 5 should beentitled to a free State education; this is not seen as a subsidy for working parents but aninvestment in each child’s future and in the quality of the future workforce. 80% ofmarried mothers and 57% of single mothers whose youngest child is aged 5 or over are inwork35, so at this age Child Benefit will revert to £18 per week.

Modern reality demands that state funding for pre-school children should be increased,broadened and simplified. There are currently various overlapping systems to help parentspay for nursery fees, including Child or Working Tax Credits, the Nursery voucherscheme, whereby a higher rate taxpayer saves £89 a month but a basic rate taxpayer savesonly £72, and Early Years Funding, of £11 per day for children aged three or over. Theentry for “Under Fives” under the heading Education and Training in the Public SectorExpenditure survey for 2005 shows a total cost of £4.1 bn. The total cost of all theschemes mentioned above is much higher, but the bulk of this is already taken intoaccount elsewhere, for example under Child Tax Credits.

34 So the fairly ludicrous means-tested “Education Maintenance Allowance” will be superfluous35 Table 1 “Families and work” Annette Walling, ONS, spring 2004

PART B: DETAILED PROPOSALS: CHILD BENEFIT


Impact

Whether and how soon a mother wishes to go back to work after having children is ofcourse an intensely personal decision. The BCB will enable a mother to stay at home forlonger if she so wishes; and improving nursery funding will enable her to return to worksooner if she so wishes.

Keeping within current expenditure levels, it seems fairest to pay a flat £60 per weektowards the nursery costs of each child aged 2 - 4. £60 only covers half the cost of a fulltime nursery place in London but it probably covers a larger percentage elsewhere.Further, if a parent goes back to work part time, the £60 might well cover the bulk ofthese costs.

The subsidy will be cheap and simple to administer. Increasing the subsidy to eventuallycover the full costs of a nursery place for all children from the age of 2 will be relativelycheap overall;

- It will only be paid to registered nurseries, and working mothers pay more taxthan non-working mothers, a lot of it will come back to the State in the forms oftax receipts;

- If the age at which a child is entitled to a free State education comes down, thenthe age at which Child Benefit reverts from £36 to £18 per week will come downas well.

Current payments (2004-05)Child benefit (incl. Child Trust Fund)36 £9.8 bnChild personal allowances (from Proposal 6) 37 £3.7 bnChild Tax Credits38 £3.1 bnNursery funding39 £4.1 bnTotal £20.5 bn

Expected paymentsChildren aged 0 – 4, 3.5m @ £36 per week £6.5 bnChildren aged 5 – 16, 9.1m @ £18 per week £8.6 bnChildren aged 17 – 18, 1.4m @ £24 per week £1.8 bnLess 2% fall in number of children since 2001 Census £(0.3)bn2,100,000 children aged 2 - 465%40 of young mothers in employment =1,365,000 @ £60 x 50 weeks = £4.1 bnTotal £20.5 bn

36 HMRC Annual Report 2004-0537 Department of Work & Pensions, Table 3, 2004-05 estimated outturn, unless stated.38 £13.8 bn entitlement less £4.4 bn negative income tax x one-third, see Proposal 6.39 Public Expenditure Statistical Analyses, 2004-05 estimated outturn.40 Assuming that the percentage of young mothers in work increases to typical rates where the youngestchild is 5+

PART B: DETAILED PROPOSALS: BENEFITS


Proposal 7. A Basic Cash Benefit

• All income style benefits will be replaced with a non-contributory, non-meanstested, non-taxable Basic Cash Benefit (“BCB”) of £80 per week for every adultaged 23 or over who earns less than £11,000 per annum;

• BCB claimants will not also be entitled to a personal allowance for tax purposes;• For the avoidance of doubt “every adult” includes existing key benefit claimants,

younger pensioners, non-working spouses, full-time mothers, students, actors“resting” between jobs, tramps, surfers and ex-convicts;

• People aged 18 – 22 will be entitled to a BCB of £52 per week;• From the age of 60, the BCB will increase by £3.75 per week for each year of age,

to dovetail with the Citizen’s Pension at age 66 (see Proposal 8).• There is an 80% overlap between Housing Benefit claimants and social tenants.

Social rents will be set on the basis of needs and ability to pay; there will thereforebe little need for a parallel system of Housing Benefit;

• Claimants of Incapacity Benefit will also be entitled to the BCB of £80 each;• There will be no changes to extra benefits paid to the truly disabled who are

genuinely incapable of doing any work whatsoever; or could work, but faceinsurmountable discrimination by employers, or who simply face extra costs toenable them to cope with daily life.

Rationale

Currently, there are around 5 m claimants of “key benefits”41 and 2.7 m people aged 65 orunder who receive the Basic State Pension. 7.8 m people aged 65 or under will be entitledto the BCB. The tiny balancing figure consists presumably of married mothers (see PartC) and students (see below). This hopefully puts paid to the misconception that a“Citizen’s Income” or “Universal Benefits” will be unaffordable.

It is quite clear that if BCB claimants work part time that the BCB should be taperedaway, however, it is much simpler and cheaper to deal with this via the PAYE system,which will be achieved by not also allowing them to claim the personal allowance againstemployment income.

Under the current system, there is little motivation for many benefit claimants to take upemployment. Although Working Tax Credits are supposed to encourage work, on thewhole they merely encourage people to earn or work just over the low threshold thattriggers WTC, but to go no further than that; the marginal tax rate plus benefitswithdrawal is then close to 100% of gross wages earned.

Further, unemployed young people receive much more generous benefits than students,which actively discourages them from training or studying.

Social landlords allocate council housing on the basis of needs at the time of application,but tenancies seem to be for life. Social rents are just over half of market rents, so there islittle motivation to move out again once you have found a job and/or your children have

41 DWP Quarterly Statistical Summary October 2005. The phrase is a tacit admission that IS, JSA and IBare interchangeable.



grown up. Turnover in the social sector is thus very low and waiting lists arecorrespondingly long. Because the bulk of social tenants cannot afford to pay the headlinerent, there is a parallel system of Housing Benefit, with yet more form filling and meanstesting.

Impact

Under the new system, somebody who earns less than £11,000 will be able to claim theBCB of £4,160 per annum and waive the personal allowance for tax/PAYE purposes; aBCB claimant will pay income tax on all earnings but not also suffer benefits withdrawal– these net payments are included in Workings 2 – so at least doubling the net wages thatthey earn for each hour worked. At a taxable income of £11,000 (the true personalallowance), the tax paid (38% x £11,000) is equal to the BCB claimed.

For a more detailed exploration of the rationale and impact of such a benefit system,please refer to Christopher Monckton’s invaluable article of 199342

The rate for 19-22 year-olds will be halfway between the rate for 17-18 year-olds and theadult rate, i.e. £52 per week or £900 per term. There will be no need for a separate systemfor student grants. Together with the fact that tuition fees don’t have to be repaid untilyou start work, this seems to make Higher Education perfectly affordable to all and to befair as between students and NEET’s43. Students will have “used up” 65% of their tax-free personal allowance if they claim the £52 per week BCB, so will be given a PAYEcode with a reduced tax-free personal allowance of £3,850 (on an annual earnings basis),so that they can earn up to £3,850 tax-free per annum with holiday/weekend jobs.

Many on the Right have called for the reinstatement of the Married Man’s Allowance.Paying a non-working spouse £80 BCB per week have exactly the same effect; the totaltax bill for a working spouse who earns £22,000 minus the BCB paid to the non-workingspouse will net off to nil.

Tenants in social housing will be allocated to Categories according to currentcircumstances, for example Category 1 for single pensioners and the severely disabledwho pay 10% of market rents, through Category 3 for lone parents up to Category 10, forcouples who pay full market rent. Tenants’ circumstances will be reviewed regularly,which will encourage the “better off poor” to move out of social housing into the privatesector, freeing up social housing for those stuck on the waiting lists.

The new system will be blindingly simple. All you will need to claim is your passport,proof that you have been resident in the UK for at least ten years (or whatever), your NInumber and a sworn statement that you are not working, or at least, not working and

42 http://www.citizensincome.org/filelibrary/Archived%20Bulletins/1993%20Bulletin%2016%20July.pdf.Christopher Monckton worked in Margaret Thatcher’s Policy Unit in the 1980s, but his approach has beenwelcomed across the political spectrum – from Lynne Jones MP (Lab) to the Green Party.43 Not in Education Employment or Training



claiming the personal allowance. The BCB will be paid into bank accounts44 by directdebit, which should help reduce fraud.

A simpler system must also mean savings to the taxpayer in terms of running costs, whichare quite significant. The DWP has 120,000 employees, and there may be as many againworking for local authorities, Job Centres, Citizens’ Advice Bureaux, DfES etcadministering all the overlapping and parallel systems. If a quarter are retained toadminister the new system and a quarter to sniff out benefits fraud, 100,000 civil servantscosting £20,000 each will no longer be needed, or a £2 bn saving.

Lynne Jones MP (Lab, Birmingham Selly Oak) puts the cost of administering means-tested benefits at 10% of the benefits paid out; means-tested benefits under the currentsystem are about £45 bn. Even if the true cost is 5% rather than 10%, a £2 bn savingseems realistic.

One might expect to find Tax Credit spending in the normal DWP or HMRC tables. Infact, it is tucked away in HMRC’s Annual Report “Trust Statement”. The entitlementfigure of £13.8 bn has been used as the basis for benefit spending, rather than the £15.8paid out. £2 bn overpaid tax credits have been hidden under “Debtors”, on the pretencethat these are largely recoverable. The new system will not have any such overpayments.Assuming that annual overpayments of £2 bn can be avoided, this saves an additional £2bn that will otherwise have to be written off every year.

Current payments (2004-05)45

Housing Benefit (55% paid to social tenants) £7.1 bn46

Income Support (under 60) £10.0 bnJobseeker’s Allowance £2.2 bnLess child personal allowances (see Proposal 6) £(3.7) bnIncapacity Benefit £6.7 bnTax credits47 £6.3 bnMaternity allowance, SPP and SMP £1.5 bnOther small benefits £0.5 bnTotal £30.6 bn

Expected payments/savingsBCB (see Workings 5) £30.6 bnSavings in benefit administration costs £2.0 bnTax Credit overpayments £2.0 bn

44 Any bank that makes it difficult for BCB claimants to open a basic account will have its banking licencewithdrawn. These accounts need not allow overdrafts but should at least allow Direct Debits, thus savingpoor people a few quid on their utility bills!45 Department of Work & Pensions, Table 3, 2004-05 estimated outturn, unless stated.46 Total HB is £13 bn. Around 25% is paid to pensioners, 20% to private tenants and 55% to social tenants47 Total entitlement per HMRC’s Annual Report for 2004-05 £13.8 bn, less £4.4 bn treated as negativeincome tax, per HMRC Table 2.9. Two-thirds treated as normal benefits and one-third as Child Benefit

PART B: DETAILED PROPOSALS: PENSIONS


Proposal 8. Citizen’s Pension

• The basic state pension, the Pensions Credit and sundry other age-related benefitswill be scrapped/amalgamated;

• From the age of 66, the BCB (see Proposal 6) will transmute into a “Citizen’sPension”48, non-contributory, non-means tested, non-taxable, independent ofgender, marital history or status of £106.25 per week, increasing by £3.75 a weekfor every additional year of age (the “escalator”) up the age of 71, when it reachesa maximum of £125 per week (the “plateau”).

Rationale

It is fair to say that the UK pensions system is hideously complicated.

The Basic State Pension – with complicated rules for entitlement, and which isinsufficient to guarantee any acceptable minimum living standard - is unfair to womenbecause it is earnings related, so women on average only receive three-quarters of theBasic State Pension. On the other hand, it is unfair to men as they have to work five yearslonger and die younger. Under the new system, men and women, married or single, willbe treated exactly the same.

The BSP is thus overlayered with a panoply of schemes subsidised, taxed, regulated andadministered by the State.SERPS/S2P; Contracted out pensions; Employer’s final salaryschemes; Personal pension schemes/defined contribution schemes; the Pensions Credit49,Social security benefits (e.g. Housing Benefit); other age-related benefits and in futureLord Turner’s NPSS etc.

These schemes are really based on two assumptions, one valid, one not:- That the most unfortunate 20% in society who reach retirement age without even

having managed to buy their own home were in no position to save for retirement.There has to be a cast iron safety net for such pensioners. However, this issmothered with means testing, which discourages people on low- to-averageincomes from saving privately.

- That the remaining 80% of retirees (including by definition many on low- toaverage incomes), who have the foresight to buy their own home with, and to payoff, a repayment mortgage (rather than just pay the interest on an interest-onlymortgage) in order to build up assets and ensure that they can at least live rent freein retirement, are not economically rational enough to also put some money awayfor retirement50. Tax subsidies for pensions add at least 2% to the rate of incometax, suffered by all, but the relief is badly targeted and benefits mainly higher ratetaxpayers and the insurance industry (see Proposal 10). Those in the middle loseout on both sides of the equation.

48 There will of course be no real difference between the BCB and the Citizen’s Pension, you can chooseany age you like at which it is renamed.49 Around a third or a half of those entitled are too proud, intimidated, naive or lazy to claim50 “We are not stupid. We know what we are doing”, according to Prof. Tim Congdon 7/3/05



Age-related benefits include the 25% of Housing Benefit paid to pensioner households.Around 20% of pensioner households are in social housing and claiming HousingBenefit; to compensate for the fact that Housing Benefit for social tenants will bescrapped, single pensioners in social housing will fall into Category 1, meaning they onlypay 10% of market rents (see Proposal 7).

Impact

According to the IPPR, “‘living in poverty’ would mean an income of less than £210 for aretired couple, and £128 for a single retired person.”51. With a Citizen’s Pension, no olderpensioner and no pensioner couple would be living in poverty. This will especially benefitwomen without a full contributions record, who often slip through the Pensions Creditnet.

Even if the increase in the income of poorest pensioners is modest, a Citizen’s Pensionwill greatly enhance pensioner dignity because they will not need to fill in endlessintrusive forms for Pensions Credit, Housing Benefit and Council Tax Benefit.

For the medium term impact, please refer to the invaluable PPI/NAPF interim report onthe Citizen’s Pension of late 200452, which, on the basis of international evidence,concluded that a Citizen’s Pension encouraged rather than discouraged private pensionsaving, even in countries which do not give tax relief for pension contributions.

Current payments (2004-05)53

Contributory Retirement Pension £41.3 bnPension Credit (guarantee credit) £5.1 bnHousing Benefit (25% of total) £3.3 bnWidow’s and bereavement benefits £0.9 bnWinter fuel payments £2.0 bnCarer’s allowance £1.1 bnOver 70s payments £0.5 bnOver 75s TV licence54 £0.4 bnPension Credit (savings credit) £0.9 bnTotal £55.5 bn

Expected paymentsCitizens’ Pension (see Workings 6) £55.7 bn

51 http://www.ippr.org.uk/pressreleases/?id=213552 http://www.pensionspolicyinstitute.org.uk/news.asp?p=100&s=2&a=053 Department of Work & Pensions, Table 3, 2004-05 estimated outturn54 The TV Licence fee will be scrapped – see Proposal 5.



Proposal 9. State Second Pension and Contracting out

• Existing SERPS pensions will continue to be paid out under current rules. To dootherwise would amount to a massive fraud;

• Accrued entitlement to SERPS, or S2P as it is now known will be frozen atcurrent values. No further entitlements will accrue;

• SERPS/S2P will be non-taxable.

Rationale

Everyone who has paid NI contributions, but is not yet receiving a pension, will be sent astatement from DWP showing what their NI record is, and to what SERPS/S2P they willbe entitled, expressed in £ or as a percentage of the BCB of £80 per week.

If the Second State Pension and NI are scrapped, it goes without saying that contractingout will be scrapped as well, as there will be nothing out of which you can contract.

Impact

There will probably be more unpleasant surprises that pleasant ones, but at least everyonewill have some certainty and if necessary will be able to start saving accordingly.

SERPS/S2P currently costs £7.455 bn per annum. Assuming that the cost of SERPS/S2Pfades to nothing over the next fifty years, the simplistic answer is that the additionalsaving will be £150m a year.

Actually, and actuarially, at a discount rate of 4%56, the NPV of an infinite number ofannual payments of £7.4 bn is £185 bn. The NPV of a series of payments reducing from£7.4 bn to nil over fifty years is £117 bn. The difference of £68 bn multiplied by 4% is£2.7 bn, so in theory the saving is £2.7 bn per annum.

Annual saving £2.7 bn

55 DWP Table 356 A fair discount rate for Government liabilities/borrowings



Proposal 10. Private pension schemes

• Income tax relief at the full 38% for private pension contributions will be reducedto the first £4,400 of contributions;

• Private pensions will be paid after income tax at the normal rate of 38%, subject totransitional arrangements (see Workings 2);

• The requirement to take an annuity at age 75 will be scrapped. If the member diesbefore he takes his pension, the fund will be paid to his heirs after deducting 38%quasi-PAYE.

Rationale

Tax relief for pension contributions is largely pointless and probably counter-productive.- Some countries give little or no tax relief for pension contributions, and the

amount saved is not materially lower;- Higher rate taxpayers can afford to contribute a larger slice of their income and

obtain double the amount of tax relief; these are people who probably could andwould have saved up anyway;

- For basic rate taxpayers, the relief is not a relief but a deferral; the fact that thepension fund can grow tax-free is irrelevant as they would not pay tax ondividends, interest or capital gains from investments held directly or in an ISAanyway. What little tax saving there is, is wiped out by the fact a significant partof their fund is swallowed up in administration fees, up to 30% of the final fundvalue;

- Thus ultimately, half the value of the tax relief accrues to wealthier taxpayers andhalf to the insurance industry;

- The NPSS will exacerbate this; in the short term it will be an additional burden onemployers and eat into profits; in the medium term it will lead to lower salaries;

- The tax relief for pension contributions adds about 2% to the overall tax rate,suffered by all, including those who cannot afford to opt in or to makecontributions, who thus lose out on both sides of the equation (lower salaries andhigher taxes);

- The £215,000 limit for tax relievable contributions means that the richest 500,000taxpayers would be able to buy up the entire FTSE All Share index within twodecades and claim tax relief;

- The upper limit for tax relievable contributions should be set so that it is withinreach of the average taxpayer, once he has paid off the mortgage. Further, the totalvalue of shares and the amount of corporate and Treasury bonds in issue is suchthat even if one-third of taxpayers made the maximum contribution of £4,400gross, fairly soon all quoted shares would be in pension funds and all interest paidout on corporate or Treasury Bonds would be recycled as pensioners’ annuityincome.

If, as at present, one third of employees and the self-employed make contributions57, therewill be no significant overall change in the amount of tax relief for private pensioncontributions (£15 bn - £25 bn) but the value of the relief will be spread more evenly.

57 HMRC Table 3.8

PART C: TAX, BENEFITS & THE FAMILY


Background

While it is important to consider the tax/benefits position of a single employee or UK plcas a whole, it is equally important to consider the impact that the changes will have onfamilies at various income levels.

The current government has always made great rhetoric about the measures it is taking tosupport and reward “hard working families. On a closer examination this is pure rhetoric;whether by accident or design, the UK’s tax and benefit system discourages marriage andminimises rewards to hard work.

Consider the examples on the following pages of Ms Welfare, Mr & Mrs Low Pay andMr & Mrs Average under the current system;

If Ms Welfare starts working – probably at a low wage – she will face a marginaltax/benefits withdrawal burden of 70% to 100%58 up to a gross income of £20,000 or so;hardly an incentive to start work.

If Ms Welfare’s low-earner boyfriend on wages of £240 per week moves in, thehousehold’s cash income after housing costs increases by a mere £85 per week, barelyone-third of his gross wages. They are financially discouraged from forming a family.

If Mr Low Pay struggles up the ladder to become Mr Average on £24,000 per annum, anddecides it is time to buy a home for the family, the family’s net cash income after payingoff an average mortgage does not increase at all.

Finally, the real financial barrier that prevents Mr & Mrs Average from having children,is the loss of her wages for a few years before the children are at school and she can goback to work. For many average income couples who have just started paying off amortgage, this is an impossible proposition. If Mrs Average gives up work to havechildren, their net income after mortgage repayments falls by half.

Impact

Although Ms Welfare’s net cash income may fall slightly in the short term, the shortfallcan easily be made up by claiming maintenance from the absent father or working oneday a week, even at the NMW59. She will not lose any benefits, although the whole of herwages will be taxable. The costs of the necessary nursery place(s) will be largely covered(see Proposal 6). 55% of single mothers actually have a job, so this cannot be anunreasonable burden.

If Ms Welfare’s low earning boyfriend moves in, the household’s net income increases by£160 per week, they will keep two-thirds rather than one-third of his gross wages.

58 see the DWP’s Model Tables at http://www.dwp.gov.uk/asd/asd1/TBMT_2005.pdf59 8 hours x £5.05 less 38% tax = £25



If Mr Low Pay struggles up the ladder and out of social housing etc, the family’s netweekly income will increase by a quarter after mortgage repayments, rather than stayingmuch the same under the current system.

Under the new system, not only will Mr & Mrs Average be better off by £48 per weekbefore they have children, the fall in income (after mortgage repayments) that they suffer,should she take a few years off work is only a quarter of their “pre-child” income (asopposed to half under the current system); hopefully enough to enable them to afford tohave “2.4 children” (if they so wish).

In fact, for a few years, Mr and Mrs Average’s net income will be higher than their grossincome; once the children are old enough to go to school, their net income will be roughlyequal to Mr Average’s gross wages, i.e. their taxes and benefits net off to nil. At thisstage, Mrs Average will go back to work like 80% of married mothers whose youngestchild is aged 5 or over60.

Conclusion

It is broadly agreed that a stable family unit with at least one working parent is animportant factor in ensuring positive outcomes for children, in terms of health, education,employment and avoiding a life of crime. The tax/benefits system proposals suggestedhere will make some inroads into the depressing statistic that more than a quarter ofchildren grow up in a single-parent household - divorce law is probably as much toblame61 - but surely anything is better than nothing!

Ms Welfare62

The weekly benefits claimed by “Ms Welfare” (unemployed, single, two children under5) under the current and the new system can be summarised as follow:

Current NewCash benefits less expenses System63 SystemIncome Support/BCB £56 £80Child Benefit £28 £72Tax credits £73 N/aWelfare foods £6 £6Less Local Authority rent £(53) £(30) Category 3 – See Proposal 7Housing Benefit £53 N/aLess Council Tax/LVT64 £(15) £(4) See Proposal 5Council Tax Benefit £15 N/aCash income £162 £140Fall of £22

60 Table 1 “Families and work”, Annette Walling, ONS, 200461 See Dr Andrew Lilico’s article athttp://www.bowgroup.org/harriercollectionitems/Signed%20Off%20Crossbow.pdf62 Jill Kirby “The Price Of Parenthood”, CPS, 200563 The “current” figures are based on 2004-05 rates and allowances64 Assuming her council flat is worth half the average home in the UK, _ x £179,000 = £90,000, £90,000less £70,000 exempt band = £20,000 x 1% LVT = £200, = £4 per week.



Mr and Mrs Low Pay65

The weekly net cash income of Mr and Mrs Low Pay (he earns half the average wage,£12,000, she is at home with two children under 5) under the current and new systems is:

Current NewCash benefits less expenses System SystemNet salary £190 £223Tax credits £96 N/aMrs Low Pay, BCB N/a £80See Proposal 6Child Benefit £28 £72Welfare foods £6 £6Less Local Authority rent £(53) £(70) Category 7 – See Proposal 7Less Council Tax/LVT66 £(20) £(10) See Proposal 5Cash income £247 £301Increase of £54

Mr and Mrs Average67

The weekly net cash income of an average couple (he earns £24,000, she earns £18,000)before housing costs is as follows:

Current systemChildless

2 childrenunder 5

Mr Average, net wage £345 £345Mrs Average, net wage £268 £0Tax credits £0 £11Child Benefits £0 £28Mortgage repayments £(120) £(120)Council Tax £(20) £(20)

£473 £244Fall of 48%New systemMr Average, net wage £366 £366Mrs Average, net wage £295 £0Mrs Average, BCB £0 £80 See Proposal 6Child Benefits £0 £72Mortgage repayments £(120) £(120)LVT68 £(20) £(20) See Proposal 5

£521 £378Fall of 27%

65 Jill Kirby, op cit.66 Assuming their council house is worth 2/3 of the average home in the UK, 2/3 x £179,000 = £120,000,£120,000 less £70,000 exempt band = £50,000 x 1% LVT = £500 = £10 per week67 Jill Kirby, op cit.68 Assuming an average value house in the UK, worth £179,000, £179,000 less £70,000 exempt band =£109,000 x 1% LVT = £1,090, = £20 per week.

PART D: ADDITIONAL GAINS: ECONOMIC GROWTH


The workings for each Proposal contain the economist’s usual assumption of ceterisparibus. Of course, wages and prices, and hence profits will adjust; it is impossible toforecast all these effects and how they interact. However, some things are fairly certain:

Firstly, when Employer’s NI is scrapped, labour will be cheaper and UK plc will have25% more pre-tax profits available to spend on labour (see Proposal 2). Assuming theprice-elasticity of demand for labour is unity, scrapping NI, which adds 8% to the averagewage bill, will increase the number of employees by 8%. UK plc currently employs 20 mpeople, if this increases by 8%, that’s an extra 1.6 m jobs. If, as is likely, the demand forlabour is price elastic, then an 8% price reduction will lead to a much greater increase indemand for labour. Using David B Smith’s formula69, scrapping Employer’s NI is animportant step to full employment.

Secondly, under the new system, returns to labour will be greater. Benefit claimants willnet twice as much for each hour worked; average earners will see their net salaries rise byover 5%; the net marginal salary of higher earners will increase by 5%. Thus there will bea greater supply of labour, even without any changes to headline wages and salaries.Around 1% of man hours in the private sector will be diverted from form filling toproductive work, generating taxable income.

This leads to one inescapable conclusion. If UK plc is looking to add at least 1.6 memployees and many more benefit claimants are ready for work and if average and higherearners are willing to work 5% more (assuming price elasticity of supply is unity), thensurely the level of employment will increase to more or less full employment.

Even if only 1.6m NMW jobs are created at £11,000 per annum, this might not raise anyPAYE but will save £6.7 bn in benefits. Assuming UK plc makes the same mark-up onsalaries as it does generally, i.e. 50%, the extra turnover will be £26.4 bn; extra VAT willbe £1.6 bn70 and extra corporation tax on the net mark-up will be £3 bn. The totalsaving/extra revenue will be £11.3 bn.

This extra growth is 2% of GDP, so not unrealistic. Smallish changes in unemploymentover a year mask the fact that each year, hundreds of thousands of jobs are lost (forexample, to India and China) and hundreds of thousands are created. The overall increasein employment of 1.6m will manifest itself in a year or two if the rate of job losses isslowed and the rate of job creation is increased.

69 See Workings 170 VAT is around 6% of GDP, or alternatively, goods account for one third of GDP and are taxed at 17.5%

PART D: ADDITIONAL GAINS: BETTER COMPLIANCE


LVT will be administered by one single body and will be paid by the owner, not theoccupant, so it will be easy to do “data mining” to identify people who own more thanone property, and who probably have rental income. If HMRC have nothing better to do,they can trawl the Yellow Pages for painters and decorators and see whether any of themare actually registered for tax. Rather than engage it interminable PAYE inspections thatraise a little extra tax on largely technical matters, HMRC staff should be trawlingbuilding sites, restaurants and other places where PAYE evasion is rife.

HMRC will check that full PAYE has been paid when it reviews the accounts. If not, thesalaries will simply be disallowed as a tax-deductible expense71. In marginal situations,employers will prefer to err on the side of caution and deduct full 38% PAYE fromsalaries, which will tend to boost PAYE receipts. An employee who is legally resident inthe UK will be able to claim the BCB to compensate for this.

When somebody on benefits takes on a part time job, he is better off working for £3 perhour cash in hand than being paid £6 legally and losing nearly all of it in tax and benefitwithdrawal. The employer is happy to forego the corporate tax deduction for the £3, soboth parties come out ahead. Once an employer has got that far, he might decide to divertsome income into an untaxed pot which is used to pay such wages, this is where the realtax evasion comes in, it is just the end of a slippery slope. A simpler and fairer tax andbenefits system will no longer reward this strategy, so compliance will improve.

The shadow economy is estimated to be more than 10% of GDP72, or £120 bn per annum.If VAT and income tax can be collected on even one quarter of this, it will increaserevenues by £30 bn x 44%73 = £13.2 bn

Companies and groups will pay tax on their accounting profits, so the onus will be on thecompany to provide explanations if the tax paid is less than accounts profits x 38% andexpenses paid to non-tax treaty territories will as a general rule be disallowable. Theburden of proof will be on businesses claiming an expense as a deduction to show thatthey can identify the supplier; HMRC will be able to use this information to test whetherthe supplier is under-declaring income. Such sensible measures will improve receipts,although it is impossible to forecast by how much. There will no longer be any advantagein reclassifying income between Schedules or entities to take advantage of lower rates asall income will be charged at the same rate.

The likely additional revenues from the boost to the economy and by broadening the taxbase will be in the order of £20 bn - £30 bn, sufficient to maintain government spendingat its current level without going into the red, or sufficient to cut the headlineincome/corporation tax rate by 2% - 3%.

71 Some companies have successfully claimed salaries as an expense way in excess of the amounts shownon the P35; this only works because corporation tax and PAYE are monitored by completely separateoffices.72 Guardian Unlimited – 11 January 200573 Income/corporation tax plus 6% for VAT.

PART E: WORKINGS


Workings 1. National Insurance

Ignoring minor sources such as Class 1A, 2, 3 and 4, NI can be broken down further asfollows:

Employees’ NI - 45% £35.1 bn £35.1 bn (see Proposal 1)Employers’ NI - 55% £43.0 bnOf whichUK plc – 71.4% of employees £30.7 bn (see Proposal 2)State – 28.6% of employees74 £12.3 bn

£78.1 bn

National Insurance will be scrapped as a separate tax.

Rationale

Most basic rate employees genuinely believe that they only pay 22% tax; the NI element“goes towards their pension”. This is quite simply not true; current NI goes towardspaying current pensioners. The Basic State Pension system on its own is incapable ofproviding a safety net against pensioner poverty anyway, see Proposal 8. In truth, NI is asuper-tax on employment; whatever the price-elasticity of supply and demand for labourare, the effect of NI is to increase the cost of labour to employers, reduce the net wagesearned and to reduce employment levels.

Studies have been carried out comparing total payroll taxes75 with unemploymentlevels76, and although there are many other factors in play, the “line of best fit” shows thatunemployment is basically one-fifth of the NI burden as a percentage plus a residual1.5%. The total NI burden in the UK is around 20%, one-fifth of that is 4%, 4% plus1.5% equates to a 5.5% unemployment rate, which is not far off the official figure for UKunemployment.

Impact

Scrapping Employer’s NI will tend to boost employment levels, see Part D.

Scrapping Employer’s NI on State employees’ salaries will have absolutely no effectwhatsoever, as the tax revenues lost to the Exchequer are equal to the amount saved bythe State qua employer.

The Citizen’s Pension will be non-contributory (see Proposal 8), so there will be no needto maintain NI records and contracting out will end.

74 Labour Force Survey Winter 2005-0675 i.e. above and beyond normal income tax76 Allister Heath and David B Smith “At a price! The true cost of public spending” Politeia, 2006

PART E: WORKINGS


Workings 2. PAYE on pension and employment income

PAYE and Employee’s NI is the single largest source of revenue, so it is important toforecast the likely receipts very carefully.

PAYE – employees (1)

The incremental approach says thati) 20 m employees earning more than the personal allowance will be on average

£920 better off (see table in Proposal 1); 5 m employees earning less than thepersonal allowance, will be on average £1,200 better off (i.e. BCB less incometax exceeds the income tax due under the older system). Taking the twotogether PAYE receipts will fall by £24 bn.

ii) Of £60 bn employer and private pensions paid out, currently only £45 bn issubjected to tax, largely at 22%, total receipts £10 bn. Taxing £60 bn in full at38% raises £23 bn, which will increase the total take by £13 bn, less £1 bntransitional relief - see Pensioners (2), total increase £12 bn.

iii) £23 bn BSP and SERPS/S2P was reported to HMRC for 2004-05, largelytaxed at 22%, so the tax raised was £5 bn. The CP will be non-taxable, so thiswill lead to a fall in PAYE receipts of £5 bn.

iv) Contracting out costs £11 bn and will be scrapped. Allocating 45% of this toemployees will increase PAYE revenues by £5 bn.

The incremental approach suggests that PAYE receipts will thus fall by about £12 bnfrom 2004-05 total receipts of £139.4. The more detailed working on the following pagessuggest a fall of similar magnitude

Employees (2) £99.9 bnPensioners (1) £12.8 bnPensioners (2) £3.7 bnPensioners (3) £4.8 bn

£121.2 bn

PART E: WORKINGS


PAYE – employees (2)

The latest version of HMRC’s Table 3.6 is for 2003-04, so the personal allowance of£11,000 has been reduced by 5% for one year’s earnings growth and the tax liabilities/netBCB calculated accordingly.

Employees earning less than the personal allowance will be entitled to the BCB, but willhave to pay tax on all their wages. The workings for Proposal 7 assume that employeesand BCB claimants are mutually exclusive; this is of course not the case, workers on lowwages will also claim the BCB but the PAYE that they suffer will reduce the cost of this.This should strictly be classed as benefit spending but for simplicity these have treated asnegative income tax.

Range of totalincome (lower

limit)

Number ofindividuals(thousands)

Meanincome

Tax lessBCB per

employee

Total

£4,615 1,220 £4,860 £(2,115) £(2.6)bn£6,000 864 £5,850 £(1,739) £(1.5)bn£7,000 877 £6,620 £(1,446) £(1.3)bn£8,000 1,740 £8,020 £(914) £(1.6)bn

£10,000 1,770 £9,850 £(219) £(0.4)bn£12,000 2,660 £12,400 £750 £2.0 bn£15,000 3,820 £16,100 £2,156 £8.2 bn£20,000 4,860 £22,900 £4,740 £23.0 bn£30,000 2,930 £33,400 £8,730 £25.6 bn£50,000 630 £51,300 £15,532 £9.8 bn£70,000 304 £69,200 £22,334 £6.8 bn

£100,000 206 £103,000 £35,178 £7.2 bn£200,000 61 £206,000 £74,318 £4.5 bn£500,000 10 £455,000 £168,938 £1.7 bn

£1,000,000 4 £1,350,000 £509,038 £2.0 bnTotal 21,956 (as at 2003-04) £83.6 bn

The table covers 22m employees, so pro-rating up forthe fact that there are now 25 m employees would givetotal receipts of …

£95.2 bn

Adding 5% for one year's nominal wage growth wouldgive expected receipts for 2004-05 of … £99.9 bn

PART E: WORKINGS


PAYE - pensioners (1)Pension income will be subject to 38% in full – the personal allowance is “used up” bythe fact that pensioners are entitled to a higher non-taxable Citizen’s Pension.

Pensioners with higher employer/private pensions will be able to waive the higher CP andclaim their existing basic state pension entitlement (pegged for sake of argument at theBCB rate) and instead and pay tax at 22% or 40% on all their SERPS andemployer/private pension.

The next table therefore only covers normal pensioners, who will rather have around£2,000 extra non-taxable CP and pay a higher rate of tax on their small employer/privatepension.

Range of totalincome (lower

limit)

Number ofpensioners

Mean privatepension

Tax at 38%

£4,615 232 £3,120 £0.3 bn£6,000 293 £3,170 £0.4 bn£7,000 474 £3,110 £0.6 bn£8,000 780 £4,180 £1.2 bn

£10,000 698 £5,480 £1.5 bn£12,000 809 £7,100 £2.2 bn£15,000 825 £9,020 £2.8 bn£20,000 682 £12,800 £3.3 bn

Total 4,793 £12.2 bn

Adding 5% for one year's nominal pensionsgrowth would give expected receipts for 2004-05 of … £12.8 bn

Documents

Tax, Benefits, Pensions Keep it simple Part 2: Ten steps ...Proposal 1: Employment and Self-Employment Income Proposal 2: Business Taxation Proposal 3: Reducing the Compliance Burden